What is Business Model and How Does it Work?
What is Business Model?
Business Model is the way a company or business plans to create value, deliver value and make money from the value it offers.
It refers to how a business intends to run in a profitable and sustainable way.
Business model highlights the products or services the business plans to offer, its identified target market, and any anticipated expenses in offering such service or products. Business models are important for both new and existing businesses. For new or developing businesses it helps them attract investment, recruit the right talent, and motivate management and staff.
And for established businesses the importance of business models can also not be overemphasized. As a matter of fact business model is one of the metric that helps them to anticipate trends and challenges ahead.
Understanding Business Model and How it Works
When someone talks about starting a particular business it is important to ask the model he or she intends to deploy. For example, a client came to me with an idea of starting a ‘food business’. I knew that food business is going to be a big hit anytime any day and almost anywhere also. In fact we have this believe that food business can never fail (of course you know that is a bit of an exaggeration). But I still have to find out the model for this particular food business the client had in mind.
And this brings me to a crucial component of business models called value proposition. Value proposition is simply the value a business promises prospective customers that they will get should they go ahead and pay for their product or service.
FYI: A value proposition is a statement that explains the value (not likely to be obtained elsewhere) which a business offers to a customer which makes for a compelling reason why the customer should buy that and not from other competing businesses.
So different models in food business offers their own value proposition. For example a food business can decide to run with any of the following models:
1. A walk in and eat in restaurant – Business Model
This is a very popular model across different cities in the world. In fact I consider it the default model for food business anywhere and you don’t need to be quite innovative to pull this through. It is the normal quick service restaurant where customers walk in, make selection from any of the available delicacies on offer and are served either to eat in or take away.
What do these restaurants offer or promise? They offer quick and freshly cooked meals anytime you walk into their restaurant. Very good examples of this are Tantalizers, KFC, Chicken Republic, Sweet Sensation and many others.
2. Recipe and Ingredients Home Delivery Service – Business Model
There are many homes where eating in restaurants pre-cooked are not an option. Two reasons are principally responsible for this: some of them consider such foods as unhygienic while others believe it is usually more expensive. Some school of though even believe that most restaurants don’t cook very healthy food. So for health-conscious people who wants to eat freshly-cooked meals on budget, innovative food entrepreneurs have a solution. Some of them have this idea of delivering just the recipe and ingredients, right at the doorstep of customers. After successful delivery of ingredients, people can cook the recipe themselves. The recipe list can be carefully curated to include only those dishes that can be cooked instantly and once.
So here you get the same quick service you get at eat in restaurant, you also get to have your food fresh. But this time around you do the cooking yourself, so you can guarantee the hygiene and the healthy nature of the food. And of course it costs less.
3. Prepared Home food delivery service – Business Model
The prepared food delivery business model is a modification of eat in restaurant service. Here the focus is on delivering delicious and healthy meals at an economical price. When a meal is ordered, the food is delivered piping hot at the customer’s doorstep. Kitchen service, as well as the online food-ordering platform, can be managed by the food startup itself under this business model.
4. Office food delivery service – Business Model
Just like the home food delivery service this focuses on delivery delicious and healthy meals at an economical price to customers in their various offices. Most restaurants run this specifically for launch. They know that professionals can get so busy with work that they won’t have the time for lunch break, so they offer them this option of placing order for their preferred meal and have it delivered to their offices.
5. Specialized food delivery service – Business Model
In the specialized food delivery service business model, meals are prepared while keeping specific requirements of customers in mind. It may include a high protein diet, low-fat diet, low-carb diet, immune system boosting diet, and more. Some times it can be local delicacies common to a particular group of people.
I known a few food startups that specializes in delivering roasted yam and plantain known as bole in Nigeria. Others focus on serving abacha, ukwa, ugba etc.
There can be many examples of such diets, but in this business model, meals are not outsourced to a restaurant or kitchen and are prepared by the food startup itself.
6. Online grocery store – Business Model
Opening an online grocery-shopping portal is a profitable business idea, which an entrepreneur can start at local community level. At an online grocery-shopping website, a visitor can order groceries delivered to his doorstep. The online grocery-shopping portal can also offer the feature of remembering the grocery list, which will make it much easier for people to order the same list again effortlessly.
Think of Amazon Fresh, think of Supermart and many others that offer this service.
7. 24 hours buffet restaurant – Business Model
Usually, in a restaurant you get to see price tags on each of the food items on offer. Or you specify the portion you want and a price is attached. But some innovative entrepreneurs are offering 24 hours buffet service at a flat rate. So in this business model you walk into a restaurant pay a particular amount and eat any food of your choice until you are full.
8. Subscription based restaurant – Business Model
This walks for both home delivery, office delivery and even eat in restaurant. The value proposition here is that customers pay upfront and guarantees the food they get for a week, a month or any specified time as the case may be.
9. Free restaurant for the less privilege – Business Model
A social enterprise is a business that is committed to offering service to a group of people at no cost. Some social entrepreneurs understand that there are less privilege children who have no one to provide for them on a daily basis and for that reason they decide to open a restaurant just to serve these ones. But for the enterprise to be sustainable there is need to thinking of how it will be funded from day one and that is where business model comes in. As with almost every other non-profit enterprise it usually rely on the donation of agencies and individuals.
It can also run with the Bombas model. In this model for each plate of food sold another plate will be sent to the orphanage or old peoples’ home.
One thing that is common with each of the points above is that they offer food service. But each of them has a different way to offer it to benefit or appeal to the customer (value proposition) and that in turn determines how they can make profit to remain in business
What Should a Business Model Capture?
I have said that a new venture needs a business model as much as established businesses do. I also mentioned value proposition as a crucial component of business models. Though certain business models are designed to fit a particular industry but there are generic components almost every business model should have. I will share a few of them here.
1. A Clear Vision
In all time and at all places, the first component of your business model should always be a clear description of where the business is heading. Just a sentence or 2 describing why you are doing what you are doing.
2. Smart Goals
Once you have established a vision for your company the next thing should be to set goals. State in clear terms what you want to achieve in the business and when. Your objectives can relate to your yearly revenue projection, marketing strategies or staff growth. It is always important to adopt the goal-setting technique made popular by the acronym SMART:
S – Specific
M – Measurable
A – Achievable
R – Realistic
T – Time-bound
This technique helps you set goals that are easy to relate yet powerful enough to stretch you.
3. Target Customer Base
When devising a business model, it’s important to identify the types of customers who would be interested in your organization’s products or services. Note their pain points as at today and be sure of how to eliminate it.
4. Solutions
Now you have identified your customers and their pain points. A good business model should now be able to include a list of the solutions you are bringing.
However, you need to ensure that the solutions you are promising are realistic considering the resources you have at your disposal. In business we day that it is better to under promise and over deliver rather than to over promise and under deliver.
5. Value Proposition
Value, as it relates to business models, refers to the central aspects of your solutions that make them unique. It is the promise you make to your customers to make them choose you.
6. Startup Cost
Startup cost is another important aspect of a business model. It has to do with the financial resources you need to be able to execute your idea.
7. Funding Sources
Now that you know what you need in terms of money the important question to ask is how do you get it?
Will you bootstrap or apply for government funding or take a loan or go for equity investors? That decision should reflect in your business model.
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8. Revenue Model
Revenue model is perhaps the most important and popular component of a business model. In fact, revenue model has become synonymous with business model in some quarters. And the mere fact that most people use the two terms interchangeably is enough to show you what an integral component it is.
However, they are not the same thing. Revenue model is only a subset of a business model. It is like referring to CPU as a system unit.
So what is a revenue model? It is that aspect of a business model that defines how the business will generate money or how to charge customers for services on offer.
So every business must be very clear on this. It must state the various mechanisms for generating income and their sources. In some businesses, pricing can be a market penetration strategy. And how much you set as your price also depends on how new you are in business or otherwise. Other factors to consider when setting prices include the quality of your products or services and your profitability targets. Once you have reached your desired net profit margins, you can start offering discounts and other special deals. It is a strategy.
FYI: It is very important that when evaluating a company as a possible investment, the investor should find out exactly how the business plans to make its money. This means looking through the company’s revenue model which in turn is contained in the business model.
9. Marketing Strategy
Market strategy involve choosing the channels you want to use to promote and sell your products or services. These vehicles can include social media platforms, mobile app, offline marketing, physical outlets, online stores etc. But whatever channel or outlet you choose must be one that your target market uses.
10. Competition Analysis
It is important you know other businesses that offer the same service or product you want to offer. And capture them in your business model. You need to study the strengths and weaknesses of those competitors. In competition analysis you have to take note of both direct and indirect competitors.
11. Growth and Partnership Opportunities
This component of your business model involves searching for ways to help your company grow. Common examples of opportunities for growth include mergers and acquisitions with other companies and partnerships with both profit and nonprofit organizations. I always advise that you find way to collaborate with even your supposed competitors. If you can find a way to leverage your competitors strengths then you have a good chance of tripling your success.
12. Yours Messaging and Promotion
Your message must be clear and powerful in order to attract attention and convince customers that your business’s products or services are worth purchasing. This message, which can be used in advertisements, must ideally reflect your company’s unique characteristics and include a call to action, such as “contact us today to receive a quote for our comprehensive auto insurance policies.” Your marketing department can help you create and communicate an interesting message and slogan.
How to Design a Winning Business Model
You don’t need to have an MBA to be able to design a saleable and workable business model. All you need to do is know the various components that make up a business model. But here is a quick guide on how to design a winning business model in 7 steps:
Step 1: Define The Problem You Want to Solve
At this stage, you need to start by looking at the problem you’re going to solve. It can be a social, emotional, religious, political or whatever functional problem it may be. The problem could be applicable to a particular location and can also be a national problem or even a global one. You can define as many problems as you can see so long as you have the necessary solutions. However, I would advise you limit to three.
Step 2: Define Your Target Customers
Who are the people that are experiencing that problem? Define a set of three types of customers maximum for the problems you defined in step one. Ideally, each problem will be matched to a customer type. At the same time, the same customer type might experience multiple problems. Or one problem can be experienced by different customer types.
Step 3: Define The Key Customer and The Key Problem
You need to choose one among the top three customer types identified and one or more of the top three problems identified, where you’ll focus your attention. A business model can evolve in many different ways. But narrowing down the course of action can lead to better execution of the business model. Thus, at the end of this step, you’ll have one key customer or alternatively one key problem to focus on.
Step 4: Define a Set of Possible Solutions
Make a list of a minimum of ten solutions that the problem can be solved with. From those ten or more, narrow down the three which can easily be implemented without too many financial resources or time resources. And among these three, pick one!
Step 5: Define a Set of Possible Monetization Strategies for that Solution
For the solution you picked, and the customer type, you’ll have defined a product or service. For that product or service define the maximum of five possible monetization strategies. Keep the two that can be quickly tested.
Step 6: Test and Choose Your Business Model
Test the product and its monetization strategy and see which worked.
Step 7: There is Your Business Model
Hurry! It is a done deal. Without much hassles and based on the key customer, key problem, the solution you provide, and the monetization model defined you have your business model!
How to Validate Your Business Model
Creating a business model is an important exercise, but a model is essentially a hypothesis. So as long as it is still on paper you can’t really bet on it. You need to test your model to prove that it will actually provide value for your customers as you have proposed. And here are some steps you can take to validate your business model:
1. Make your business model accessible and collaborative.
Customers, stakeholders, and team members are all valuable sources of feedback for improving your business model. So make it easy to update and share your model. You can use a cloud-based business model canvas or strategy tool to encourage and facilitate collaboration.
And please don’t share just for sharing sake. Maintain an open mind and be ready to amend where necessary.
2. Build out other strategic models.
Extend your strategic thinking to other types of models. How will you take your product to market and reach target customers? This should give birth to a marketing strategy. Who are your competitors? That is the competitors analysis. What opportunities and threats exist for your business? SWOT Analysis. Use a variety of modeling tools to anticipate the different market challenges that your idea may face and identify any gaps in your business model. Finally, extend your business model to a graphical template – business model canvas.
3. Turn your model into achievable goals and initiatives.
Think about what it will mean for your business model to be successful. Is it an annual revenue target? A desired number of users? Set time-bound, measurable goals and determine the initiatives, or themes of work, that will get you there. These will be important proof points for external stakeholders, such as investors or partners.
4. Plan how and when you will deliver your business idea.
At this stage, you will translate your business goals into actual product or service features. You may not have a fully fledged offering at the start of the validation process, but you should determine what you need to deliver and then start testing your business model. You could create a demo or beta version of your product and offer it to a select group of users, for example.
5. Get feedback from customers and stakeholders.
Now is the most important step for validating your business model. Send out surveys, conduct interviews, and crowdsource feedback to understand customer preferences and needs. Was your hypothesis correct? Does your business model solve a problem the way you thought it would? This feedback will help you determine which aspects of your business model to adjust.
6. Refine and repeat.
With these new insights, return to your business model template and make refinements. You can also repeat the steps of the validation process above to continue iterating on your business model.
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Difference Between a Business Model and a Business Plan?
Business models and business plans are both important tools that help you create and refine your business strategy. Many times you will use both when pursuing a new business initiative, but they are not the same thing. Each serves a different purpose. And having one does not stop you from having the other.
So what is the difference between a business model and a business plan?
A business model is the foundation of a company, while the business plan is the structure. So, a business model is the main idea of the business together with the description of how it is working. The business plan however goes into details as to how this idea could work.
Business Model captures the main idea of how your business will generate revenue. A business plan on the other hand goes into greater detail — it is a document that explains how you will make the business model work.
Your business plan will likely include your company’s goals, the resources and methods you will use to achieve those goals, and even your expected timelines and financial performance. Together, your business model and business plan describe the intended value of your product and how you plan to deliver this value to your customers.
Conclusion
Business Model is a very important tool for developing business strategy. It gives an overall outlook of the value a business intends to offer, how it will offer such and how it will make profit offering such value.
Different businesses or industries have different types of business models that are obtainable. But irrespective of the industry or type of business every business model has certain components that makes it saleable.
Today, if you are thinking of starting a new business there is every need to develop your own business model. And if you have an ongoing business it also important to keep updating your business model.
And should you need more clarity on this or help in crafting your own business model feel free to talk to us to see how we can help.